3 reasons to refinance into an ARM

ARMs are certainly not a good fit for everyone, but today's ARMs are somewhat less risky than the ARMs of the past. Rather than adjusting yearly, today's ARMs are hybrid ARMs that have a fixed initial interest rate for three, five, seven or 10 years followed by an adjustable rate. While the spread between interest rates on a 30-year fixed-rate loan and a 5/1 ARM varies, during the week of February 8, 2013, the average 30-year mortgage loan rate was 3.84 compared to an average rate of 2.76 for a 5/1 ARM. You can compare mortgage rates today to see how much you can save.

Depending on your individual circumstances, refinancing into a hybrid ARM can be a good financial move.

Three reasons to consider an ARM

You plan to sell your home. If you are certain that you will sell your home before the interest rate adjusts, then an ARM could be an excellent way to save money. Your mortgage payments and your interest payments will be lower than a fixed-rate loan, and you can always pay down your principal with extra payments if you want to build equity faster. If you believe you'll sell in five years, you may want to choose a 7/1 ARM to provide an extra cushion of time.

Your financial situation will change soon. Whether you are a law student or a medical student who will transition from school to a high-paying job in two years or know you will be finished repaying heavy student loan debt in a few years, an ARM could be a good solution. You can make lower housing payments now, but you also know that if your interest rate adjusts to a higher level in the future, you will be in a position to handle the higher payments.

You plan to retire. As part of your retirement strategy, you may be planning to sell your home. You can refinance into a 5/1 or 7/1 or 10/1 ARM and put your savings from the lowest mortgage rates into your IRA or 401(k). Just be certain of your plans, because the last thing you want in retirement would be higher mortgage payments.

ARM risks

Before you focus on the benefits of refinancing into an ARM, be sure you understand how they work. You need to know the index to which your ARM interest rate is tied and, even more important, the margins and caps. The margin tells you how much your interest rates can adjust (such as 2 points per reset) and the caps tell you the maximum your rate can increase at each reset and over the life of the loan. For example, a 5/2/5 loan can go up by 5 percent at the first reset, by 2 percent at each subsequent reset, and by a maximum of 5 percent overall. If you have a 2.76 percent ARM, then the maximum interest rate you would pay would be 7.76 percent.

As long as you understand the maximum payment you would have to make and have a plan for either moving or paying that higher housing payment, the savings from a hybrid ARM can be very beneficial to you.